Evidence for Countercyclical Risk Aversion: An Experiment with Financial Professionals

Abstract

Countercyclical risk aversion can explain major puzzles such as the
high volatility of asset prices. Evidence for its existence is, however,
scarce because of the host of factors that simultaneously change
during financial cycles. We circumvent these problems by priming
financial professionals with either a boom or a bust scenario.
Subjects primed with a financial bust were substantially more fearful
and risk averse than those primed with a boom, suggesting that fear
may play an important role in countercyclical risk aversion. The
mechanism described here is relevant for theory and may explain
self-reinforcing processes that amplify market dynamics. (JEL E32,
E44, G01, G11, G12)